A 401(k) plan is a retirement savings plan offered by many employers in the United States. The plan allows employees to save money from their paychecks on a tax-deferred basis. The money is invested in mutual funds or other investment options offered by the plan. When an employee retires, they can withdraw the money from the plan, and it will be taxed as income.
A 401(k) plan must be audited if it has more than 100 participants. The audit is conducted by an independent accounting firm. The purpose of the audit is to ensure that the plan is being managed in accordance with the law. The auditor will review the plan’s financial records, as well as the plan’s investment performance. The auditor will also interview the plan’s administrator and other key personnel. The audit report will be submitted to the plan’s sponsor. The sponsor is responsible for taking any corrective action that is recommended by the auditor.
Minimum Participation Requirements
401(k) plans are required to meet certain minimum participation requirements to avoid being subject to an audit. These requirements are designed to ensure that the plan is benefiting a broad cross-section of employees.
ADP Test
- The ADP (Average Deferral Percentage) test compares the average deferral rate of highly compensated employees (HCEs) to that of non-highly compensated employees (NHCEs). The plan fails if the ADP for HCEs is more than 125% of the ADP for NHCEs.
ACP Test
- The ACP (Actual Contribution Percentage) test compares the average contribution rate (including both employee deferrals and employer contributions) of HCEs to that of NHCEs. The plan fails if the ACP for HCEs is more than 200% of the ACP for NHCEs.
TOP-Heavy Test
- A plan is top-heavy if the sum of the account balances of key employees (those who own more than 5% of the company) is greater than 60% of the total account balances of all participants. Top-heavy plans are subject to additional nondiscrimination tests.
Failure to Meet Minimum Participation Requirements
If a 401(k) plan fails to meet the minimum participation requirements, it may be subject to a variety of penalties, including disqualification and loss of tax-favored status. Employers should work closely with their plan administrators to ensure that their plans are in compliance.
Material Financial Statements
The need for a 401(k) plan audit depends on whether the plan’s financial statements are considered material to the sponsoring organization’s financial statements.
- Plan Assets Greater Than $100 Million: Plans with assets exceeding $100 million are always considered material.
- Plan Assets Below $100 Million: Plans with assets below $100 million may not be considered material if certain criteria are met:
- The plan is fully insured,
- The plan has fewer than 100 participants,
- The plan is not a top-heavy plan,
- The plan’s financial statements are not used to support a loan or other financing.
If a plan’s financial statements are not considered material, the plan may not be required to undergo an audit. However, even if an audit is not required, it may be advisable to obtain one to ensure the plan’s compliance with applicable laws and regulations.
Additional Considerations
In addition to the materiality of the financial statements, there are other factors that may trigger the need for a 401(k) plan audit:
- A significant change in plan assets or participants
- A change in plan sponsor or plan administrator
- A merger or acquisition involving the plan sponsor
- A complaint or investigation involving the plan
IRS Audit Selection Process
The IRS uses a risk-based approach to select 401(k) plans for audit. Plans that are considered high-risk are more likely to be selected for audit.
The following factors may increase the risk of an IRS audit:
- Large plan assets
- A high number of participants
- A history of compliance issues
- A complex plan design
Benefits of a 401(k) Plan Audit
An audit can provide several benefits for 401(k) plans, including:
- Ensuring compliance with applicable laws and regulations
- Identifying and correcting errors in the plan’s financial statements
- Providing assurance to plan participants and beneficiaries
- Reducing the risk of an IRS audit
When Does a 401k Plan Need an Audit?
ERISA’s Section 103(a)(3)(A) requires that a plan with more than 100 participants (not including participants who are considered “excludable”) have an independent audit of its financial statements annually.
Plan Assets Over $100 Million
In addition to the participant count requirement, a 401(k) plan with assets of over $100 million is required to have an audit. This requirement is set forth in ERISA Section 103(a)(3)(C).
The audit must be conducted by an independent qualified public accountant (IQPA) who is registered with the Public Company Accounting Oversight Board (PCAOB).
The auditor’s report must include an opinion on the fair presentation of the plan’s financial statements and whether the plan is in compliance with ERISA.
The audit report must be submitted to the plan administrator within six months after the end of the plan year.
| Participant Count | Asset Threshold | Audit Required? |
|---|---|---|
| > 100 | – | Yes |
| – | > $100 million | Yes |
| < 100 | < $100 million | No |
Department of Labor Investigations
The Department of Labor (DOL) is responsible for enforcing the Employee Retirement Income Security Act (ERISA), which sets minimum standards for the administration of employee benefit plans, including 401(k) plans.
The DOL may conduct an investigation of a 401(k) plan for a variety of reasons, including:
- Complaints from participants or beneficiaries
- Media reports of potential wrongdoing
- Random audits
The DOL’s investigation may include a review of the plan’s documents, financial records, and investment performance. The DOL may also interview plan officials and participants.
If the DOL finds that a 401(k) plan is not in compliance with ERISA, it may take enforcement action, such as:
- Imposing fines
- Requiring the plan to make changes to its operations
- Appointing a receiver to take over the plan
Thanks for sticking with me through this brief overview of 401(k) plan audits. I hope it’s been helpful and given you a better understanding of when an audit might be necessary. If you have any further questions or want to dive deeper into this topic, feel free to give me a shout. I’m always happy to chat about the intricacies of 401(k) plans. Until next time, stay curious and keep your retirement savings on track!